This blog is all about economic and financial events happening in Mongolia.

Thursday, March 10, 2016

Gobbling up a windfall: Oil prices destined to stay low for now, India must not let this opportunity go

Ah, cheap oil, forever, whatever. The American wish is finally coming true. Forever, because the peaking oil theory – the one that said that there was only so much oil till we run out of it – has finally been laid to rest. And whatever, well, that entailed cosying up to dictators, the very ones who enabled 9/11; waging war left, right and centre; and assassinating oil honchos who proved uncomfortable to deal with, to put it mildly.

Oil is $32 a barrel (159 litres) today. Or is it $31? Wasn’t it $30 just yesterday? At the American pump, the national average has just dipped below $2 a gallon (3.8 litres). Americans are delirious. Sales of trucks, SUVs and station wagons are rocketing up. General Motors posted a record profit recently.

President Barack Obama, who was pilloried for rescuing the American car industry in 2009, can now proudly claim to be the biggest turnaround artist since Lee Iacocca. Whatever happened to GM’s highly touted electric car, the Chevy Volt? Truth be told it never got off the ground. And now, in this sea of oil, who cares if it drowns.

What is causing this downward spiral of oil prices? Is it a global recession, like the Great Recession of the 1920s that shattered world demand? No, the world economy is tepid but just about chugging along.

China has certainly caught the flu but the US is robust. Europe is the same as always, with Germany steady as a rock and most of the rest clambering onto its back. India is growing at a healthy rate if you believe the powers that be.

It is the discovery of shale oil in America, with vast quantities of oil embedded in sedimentary rock formations, that has made the US Energy Information Administration claim that the US could be energy independent in less than four years. The US has already passed Saudi Arabia as the world’s largest oil producer by some measures. But oil prices have dipped so low, they are rendering drilling for shale oil, or fracking, unattractive.

Still it continues, for America has always wanted – without being explicit about it – to break Opec, the cartel of petroleum exporting countries of which it is not a part. Citigroup claims that oil at $20 a barrel could well be the end of Opec. Now that sanctions have been lifted on Shiite Iran, it is chomping at the bit to flood the world with oil.

The Sunni Saudis are none too happy about it. Already the two are fighting proxy wars in Syria and Yemen. US secretary of state John Kerry had to practically nail them to the same table to talk about Syria, but they moaned and groaned so much that the whole conference ended in disaster.

How then will these two enemies work together in Opec? Saudi Arabia and Russia, two top oil-producing nations, have just reached a deal to freeze, not cut, their oil production, in a pact that excludes Iran. They hope that today’s low oil prices will cripple US shale oil producers and eventually restore balance in the market.

The Saudi oil minister, Ali al-Naimi, says that rising demand will slowly eat up the oversupply. The International Energy Agency says that means another two years of low prices.

There could be this to and fro in the production of US shale oil and the rest of the world’s conventional oil. But oil does not seem destined to reach $100 a barrel anytime soon, as it had even three years ago.

And if Iran breaks away from Opec, taking along with it its Shia oil-rich ally Iraq, then there would be one more independent supplier bloc on the market, fostering further competition and downward pressure on oil prices.

What are the implications of this global oil play on India? India is short on oil and imports 80% of its total oil demand. George W Bush famously said that America is addicted to oil. India is, if anything, addicted to imported oil. Indigenous oil producers such as ONGC, Oil India, and Cairn India are getting battered by cheap imports.

They used to pay a fixed levy of Rs 4,500 per tonne. The budget has gone ad valorem, which means they pay more tax when wholesale prices are high and less tax when low. But according to Mayank Ashar, CEO of Cairn India, instead of 20% the cess should have been between 5-8%.

The government has levied tax upon excise tax to prop up retail prices, gobbling up the oil windfall to reduce its fiscal deficit, fund expansive grants and loans to countries such as Afghanistan, Nepal, Bangladesh and Mongolia (yes, Mongolia), and buy the latest and greatest in military equipment from abroad. The budget has given no relief at the pump.

In the US, changes in wholesale oil prices are reflected in prices at the pump in near real time. In India, the government refuses to decontrol prices and leave them to market forces, arguing that it ate up many a loss when oil was at $100 a barrel, so why shouldn’t it make merry now.

One can only argue that oil prices seem set to remain low for years to come, and that what is in actuality a stuttering economy needs a stimulus. What better way to do that than to put some extra bucks in consumers’ pockets. Today is an opportune moment. The government must seize it.